On June 22, 2022, the American Payroll Association’s (APA) 2022 Virtual Congress held a workshop that discussed how to reduce payroll problems with reconciliations. The seminar was hosted by Susan Judah, CPP, Senior IT Systems Analyst, City and County of Denver and Karen Ward, CPP, Director of Payroll Training, APA.
What is reconciliation?
Reconciliation is the process of comparing transactions and activity to supporting documentation. This also involves resolving any discrepancies that may have been discovered. Judah noted that this process is not just for accounting.
“Payroll does not sit in a silo,” Judah said. It can be applied to the entire process of payroll from when an employee records their time to when Forms W-2 (Wage and Tax Statement) are filed with the Social Security Administration (SSA) and then issued to employees.
One of the highest costs or expenses for a company is the total compensation package for each employee (wages, employer benefit costs, employment taxes, paid leave, etc.). Reconciliation, also known as balancing, verifies the integrity of payroll system.
Judah said that balancing is not only for the sake of having accurate and consistent records. Government agency intervention at the federal and state levels may occur if the amounts withheld, deposited, paid, and reported do not balance or agree, which may result in assessing noncompliance penalties. Employers should periodically reconcile their wage and tax information to avoid noncompliance issues.
Performing reconciliations regularly throughout the year allows employers to correct discrepancies with time to spare before the process of preparing and filing quarterly and year-end tax and information returns begins, thus saving the payroll department from quarterly and year-end disasters.
Items to consider. Judah said that payroll departments should identify items/data to reconcile by taking into consideration the following categories: (1) risk level (medium/high, potential for material misstatement; low, little potential for misstatements); (2) compliance (federal, state, local, other); (3) Sarbanes-Oxley (SOX) Act of 2002 (established sweeping auditing and financial regulations for public companies); and (4) fraud prevention.
What should be reconciled?
Reconciliations should be performed on the data used by the payroll system, from the time that data is submitted for hourly employees or exception time for salaried employees, to the request of voluntary deductions from third parties.
Judah said that making sure that the payroll register (the basic payroll data record) is accurate each payroll period will save bigger headaches later when payrolls and errors have multiplied, and errors become harder to detect. She added that early reconciliation is even more important since the Form W-2 filing deadline was moved to January 31.
Items to reconcile. The workshop provided the following items to reconcile: (1) time (hours worked, non-work hours both paid and non-paid); (2) employee count (earnings, deductions, bonuses, commissions); (3) earnings (actual compared to requested); garnishments (withheld compared to payments issued by accounts payable); (4) deductions (actual compared to requested); (5) taxable wages; (6) taxes withheld; (7) employer taxes (Social security, Medicare, unemployment); (8) ACH/cash (to amount of net pay with direct deposit elections released to the bank); (9) positive pay (to amount of net pay for live checks issued on positive pay file; check number validation); (10) earnings/taxes to forms (Form 941, Form W-2, Form 940); (11) payroll bank accounts (ACH/direct deposit, checking account); and (12) third-party payments (employee retirement contributions, union dues and other program deductions, charitable contributions, insurance premiums, flexible and health spending account contributions).
When and how to reconcile?
Ward started by explaining that the employer is ultimately the one that decides when and how data will be reconciled. Where compliance is a factor, it should be considered when employers make their decisions. For example, Forms W-2 are issued annually (no later than January 31 in the year following the reported tax year) and therefore should have at least one reconciliation prior to the Forms W-2 and 941 (Employer’s Quarterly Federal Tax Return) being issued and filed.
Ward said that best practices suggest reconciling taxable wages and taxes should be done periodically throughout the year. Other items, such as the data ingested into the payroll system during the payroll processing, should be reconciled more frequently and at various times during the process itself.
Pay period, tax deposit, and quarterly reconciliations. Ward explained that with each pay period and tax deposit, the employer must ensure values produced by the payroll system agree with amounts taken from prior reconciliations and updated by amounts taken from the current payroll register and the tax deposit ledger.
Before the last tax deposit for each of the first three quarters of the year, the employer must determine whether its deposits for the quarter equal the tax liability that will be reported on the quarterly Form 941. If not, the difference should be added to or subtracted from the last deposit of the quarter. This requires reconciliation before the due date of the last deposit for each quarter.
Additional Medicare tax creates complexity in reconciling. Because Additional Medicare Tax wages and taxes are reported differently on Forms W-2 and 941, employers must alter their reconciliation methods. On Form W-2, an employee’s total Medicare wages and tips are reported in Box 5 and total Medicare tax withheld is reported in Box 6, including any Additional Medicare Tax. There is no separate reporting of the employee’s Additional Medicare Tax wages and tips on Form W-2 or in the totals for all employees on Form W-3 or its electronic equivalent.
On Form 941, the employer’s total Medicare wages and tips paid for the quarter are reported on Line 5c, Column 1, and the employer and employee shares of Medicare tax at the regular rate of 1.45% each (2.9% total) are reported on Line 5c, Column 2. The employer’s Additional Medicare Taxable wages and tips are reported on Line 5d, Column 1, and the total withheld Additional Medicare Tax at the employee rate of 0.9% (there is no employer share) is reported on Line 5d, Column 2.
Payroll bank account reconciliation.
Ward went over the following steps to be taken in reconciling the payroll bank account when it has a balance that is not zero.
- Add any deposits and interest and subtract any miscellaneous bank charges that show up on the bank statement but not on the general ledger.
- Compare the bank statement with the ledger, checking off each check withdrawal or deposit on the ledger that is listed on the statement.
- Subtract the uncleared checks from the ending balance on the bank statement.
- Compare the ending balance from the ledger to the revised ending balance on the bank statement.
- Check again to make sure that all cleared checks have been recorded, no encoding errors have been made by the bank, and all deposits, interest, and miscellaneous charges have been accounted for if the account remains out of balance.
General ledger reconciliation.
Ward also went over the process for general ledger reconciliation. There are generally five types of accounts used by businesses to classify transactions: assets, liabilities, expenses, revenue, and equity. Asset, liability, and expense accounts are typically the only ones affected by entries from the payroll department.
More frequent reconciliations.
Both Judah and Ward were a little surprised that most of the attendees polled said they did not perform a “mock year-end” reconciliation/balance process for reportable items. Only 14% of attendees said they run through this process each pay period. Some 44% said they did this on a quarterly basis. Judah noted that a quarterly reconciliation may be too late since Forms 941 are due on a quarterly basis and encouraged more frequent payroll reconciliations.
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